Morgan Stanley: Sulfur Cap Will Drive Oil Prices Higher

In an investor report released this week, Morgan Stanley analysts predicted that the IMO fuel sulfur cap will boost oil prices above $90 per barrel, an unusual consequence of shipping's new reliance on middle distillates.

When the 0.5 percent fuel sulfur content cap takes effect on January 1, 2020, the vast majority of the world's fleet will need to purchase ultra-low-sulfur petroleum fuel. Current installation capacity for scrubbers - which allow continued use of high-sulfur fuel - could equip at most five percent of all merchant ships by the time the cap takes effect, according to analysts. Since scrubbers cost millions of dollars, add complexity to the vessel and take up space that could otherwise be used for cargo, they are only a viable option for bigger ships, according d'Amico CEO Marco Fiori.

Since at least 95 percent of merchant shipping will have to use low sulfur fuel or face penalties - at least within the Paris MOU flag states - demand for gasoil will rise. According to Kurt Barrow, vice president of downstream research for IHS Markit, the refining capacity to meet the demand for low-sulfur fuel will most likely exist in 2020, but only with higher overall crude processing - meaning a higher demand for crude.

In its report this week, Morgan Stanley agreed, and it put a number on the increase: The sulfur cap may create an additional 1.5 million bpd of gasoil demand by 2020, which would require refiners to run an additional 5.7 million bpd of crude. "We foresee a scramble for middle distillates that will drive crack spreads higher and drag oil prices with it," the bank's analysts wrote. "The last period of severe middle distillate tightness occurred in late-2007/early-2008 and arguably was the critical factor that drove up Brent prices in that period."

The production of the additional distillate volumes will not be evenly distributed, Morgan Stanley noted. Some refiners - like Repsol, Reliance Industries, Valero and Tupras Turkiye Petrol - are set up to produce more gasoil efficiently, while some are not. This could mean additional ton-mile demand for product tankers to carry MGO from far-flung refineries to bunkering ports.